As described throughout this handbook of articles, the demands on the time, energy, and reputations of Directors of early stage technology companies can be heavy. Please see related document Time Commitment. There is also the growing debate about whether directors should make a meaningful investment in the company. Please see related document Director Investment.
In recognition of increased demands on Directors, there is a trend is toward signficantly increased compensation. The topic is hotly debated. Here is one rule of thumb: directors should be awarded 0.5% of the fully-diluted equity of the company for each year of service, typically 1.5% for 3 years in the form of options on common shares with a strike price set at the fair market value (this is important for tax reasons and may be a requirement of a shareholders agreement, if one has been adopted). The Chairman should receive 50% more for his extra service. The options should vest as follows: 0.5% immediately (since the Director's reputation is at stake from day 1) and the balance of 1% vesting evenly over months 13 – 26. All unvested options vest immediately on change of control. If the Director leaves, she keeps her vested options with no requirement that they be exercised.
After 3 years, the Director should be awarded a new, similarly-structured option to maintain the 0.5% per year award.
In early start-ups when little equity has been issued, a different rule may apply: The company can reserve a 10% of the fully diluted shares for a Director's pool, so that the Directors can be topped up if there is significant dilution after their appointments.
In Canada, Directors are treated as employees for tax purposes. This means that they can be awarded shares instead of options with no immediate tax consequences. If all relevant requirements are met, the tax may be deferred until the year in which the shares are eventually sold. If the shares are held for more than 2 years, then the capital gains portion of the profit can be exempted under the rules for Canadian Controlled Private Corporations, and the employment income portion may be taxed at half the normal rate. NB: The foregoing should not be construed as tax advice and all companies and directors should avail themselves of advice from qualified practitioners.
If the Company and Directors are eligible for this favourable tax treatment, then the percentage of equity awarded as shares can be less than the 1.5% amount referenced above, since the Director will not need to pay to exercise her options.
Typically, Directors of early stage companies are not awarded cash stipends, only equity, so their interests are transparently aligned with those of the shareholders who elected them. Directors may receive additional compensation for attendance at Board and Committee meetings, although that does not typically arise until the company enters the venture growth stage.